As different global economies specialize, nations can gain from trading with one another by creating abundances of those products and services that they do best. The excess of one nation’s product can then be traded to another nation holding an abundance of its own specialty under mutually acceptable terms of trade.
The output mix of two products for an economy can be represented on a production possibilities frontier (PPF), where the output quantity of one product is represented on the x-axis and the output quantity of the other product is on the y-axis.
Opportunity Cost = The amount of production lost for one product in order to increase production of another product.
Comparative Advantage – When comparing two countries, the country which can produce a product at the lowest opportunity cost has a comparative advantage in that specific product.
In a scenario where two countries both produce the same two goods and each country has a unique comparative advantage in one of the goods, the gains from trade can be calculated. This basic application shows how countries can mutually increase their respective consumption levels through trade.
International Trade Restriction
For various motivations a country may attempt to limit trade through the following policies:
- Tariffs – taxes on imported products.
- Quotas – limitations on the amount of a product that can be imported
- Voluntary Export Restraints – a case where trading partners mutually agree to limit the amount of a product that will be exported.
Governments may impose international trade restrictions to generate tariff revenue or because special interest groups of minority groups that could be hurt by free trade influence national leaders to impose restrictive trade policies.
Special interest group arguments to restrict trade:
- National security
- Infant industry – whereby a new industry needs temporary government protection from international trade in order to develop.
- Anti-dumping – domestic producers may argue that foreign firms are exporting products below their cost in order to drive competitors to bankruptcy, with the intention of later raising prices.